Why crypto price increases when market cap increases?

Question

I'm trying to fully understand how market capitalization works and it's still a bit confusing. I know that market capitalization basically is how much money is currently spent on an asset.

For example:

If Alice and Bob both bought Bitcoin worth $20, the market cap would be $20 * 2 = $40 (Price x circulating supply).

But why does price increase when the market cap increases? Let's imagine this scenario:

Alice and Bob bought again 2 more Bitcoins and now they each have 2 Bitcoins and now the market cap is 80$.

If we try to calculate the price by using price = market cap / circulating supply, it would be:

80$ (Alice's and Bob's money) / 4 (current circulating supply) = 20$ (the same as it was beforehand).

I also read that you should assume that the circulating supply is a constant, then it would make sense, maybe... But why should I even assume this, if the supply s not a constant? Can someone explain it with a clear example?

Answer 1

You can't buy more bitcoins. There are a certain number of bitcoins that exist at any given time. You can't change that by spending money.

If Alice and Bob each bought bitcoins worth $20 from Jim who had $1000 of bitcoins (and now has $960) and those are all the bitcoins that exist (50 bitcoins), the market cap is still $1000.

Alice and Bob each buy 1 more bitcoin ($20 each) and now Alice has 2 bitcoins (worth $40) and Bob has 2 bitcoins (worth $40) and Jim has 46 bitcoins (worth $920). The market cap is still $1000.

If the bitcoin price increases to $30 so that everyone wants to buy and sell their bitcoins for $30, the market cap is now $1500. Alice still has 2 bitcoins (worth $60) and Bob still has 2 bitcoins (worth $60) and Jim still has 46 bitcoins (worth $1380). Total $1500.

If there were only 3 people we probably wouldn't talk about "the bitcoin price" - instead we'd talk about the price of each individual trade. When you scale it up to 300000 people, now we can talk about "the price". They still can't create bitcoins out of thin air just by trading them.

The market cap goes up because the price goes up. The market cap is the price of a bitcoin, times the number of bitcoins. And if the price goes down, the market cap goes down.

Answer 2

First, I would not refer to the "total outstanding value" of bitcoin as "market cap". Market capitalization has a specific meaning in finance, which is the total equity value of a publicly traded company. That's calculated as the last traded price of a publicly traded stock times the total stock.

Bitcoin is effectively a commodity. No one really cares about the total outstanding value of all of a commodity, so I would question why that matters to you. But taking it for granted that it does matter, price always drives the total outstanding value. The total outstanding value never drives the price. Total outstanding value = price per unit times the total units. Price is determined by individual trading between buyers and sellers. Units is determined in bitcoins case by how many have been mined at a given time (the constant you referred to is the cap of units. Bitcoin has a hard cap on the units that can be mined, but it isn't there yet so the units can change). Total outstanding value is a function of the two previously described factors.